'Moral hazard' sometimes makes economic problems worse

Many politicians are talking about various programs to help the economy. I don't know about you, but I get really nervous when I see the words "politicians" and "economy" in the same sentence.

There is a definite role for government in the economy, but generally that role is to set and enforce the rules needed to ensure that transactions are full disclosure  no fraud  and to protect property rights. The ideas being thrown around now go way beyond that and may ultimately hurt the economy.

One concern stems from the issue of moral hazard. Moral hazard refers to setting rules that will reward bad behavior and punish good behavior.

For example, some current proposals suggest "bailing out" consumers who are in foreclosure. Many of the people who are currently in trouble on their mortgages pushed the limits when applying for loans and intentionally went way beyond their ability to pay in order to place a bet on rising housing prices. Others made responsible decisions about what they would be able to pay and are not in foreclosure.

If the government "bails out" those who made the poor bets, they are effectively taking taxes from responsible people and giving them to those who were irresponsible. That only encourages more bad behavior in the future and punishes those who made responsible decisions.

Some people argue that it is unfair for the government to bail out Bear Stearns, the investment bank that was approaching bankruptcy, and not consumers. The government did not "bail out" Bear Stearns. The shareholders received only $2 for shares of stock that were selling for $170 about a year earlier. Many Bear Stearns employees will lose their jobs. The government did agree to insure about $30 billion of the assets to encourage JP Morgan to take on more than $85 billion of debt in the deal. But without that guarantee, the collapse of Bear Stearns might have led to the collapse of many other banks.

Many of the media sound bites on the mortgage issue have focused on "predatory lending." This refers to the fact that some loan originators pushed borrowers into loans they did not understand and could not pay.

The problem with using predatory lending to justify a new program is that predatory lending occurred in only a tiny fraction of the loans in question. Plus, the problem of predatory lending is self-correcting. The institutions that bought those loans from the unscrupulous loan originators have lost millions of dollars. They will no longer buy loans from those originators, and the originators are out of business. That problem is already solved.

Other examples of moral hazard abound. For example, if the government agrees to offer free health insurance to millions of people, as some of the presidential candidates are proposing, people who now pay for health insurance will change their circumstances so they will qualify for the free health care. This is one of the reasons that the government health-care proposals in California, Massachusetts and Tennessee have collapsed; many more people than they anticipated applied for free health care. An associated problem is that when health care is free, people will want much more than when they have to pay.

Some people argue that government welfare programs also raise the issue of moral hazard. They cite statistics that show money to pay the benefits come disproportionately from people who stayed in school, did their homework and went on to college. Benefits go disproportionately to high school dropouts and people with substance abuse problems.

Others cite Social Security as raising moral hazard issues. People who save for retirement and have retirement income above a given level will pay taxes on Social Security income. People who do not save and choose to rely entirely on Social Security will not pay taxes on their Social Security income.

Yes, I believe passionately in charitable efforts, even when they come disproportionately from responsible people and go disproportionately to people who have made mistakes.

But when the government institutionalizes such programs, recipients may no longer be forced to recognize and correct mistakes. They may even come to assert that they have a right to such benefits. That starts to change behavior in ways that will make problems worse.

I believe many of the current proposals cross the line and will serve to increase future problems.

Hal Heaton is affiliated with the BYU Center for Entrepreneurship. He can be reached via e-mail at cfe@byu.edu.